A Closer Look at Pfizer’s Three-Way Split

Blogs @ The Motley Fool

Published 11:40 am, Wednesday, August 7, 2013

Last week, pharma giantPfizer announced that it was planning to split the company into three businesses -- a move that had been long anticipated by analysts and investors alike. Although this move streamlines the company’s core businesses’ financials, does it change anything for investors?

Prelude to a spin-off

In its first business segment led by Geno Germano, Pfizerintendsto group immunology and metabolic treatments together with other products that are patented until after 2015. A second segment, led by Amy Schulman, will concentrate on patented vaccines, oncology treatments, and consumer healthcare. A third one, headed by John Young, will include all of Pfizer’s generic medications and branded treatments that will go off patent before 2015.

Although these three businesses will remain under the Pfizer umbrella, their financial reports will be reported separately starting in fiscal 2014. Many investors have speculated that this split is a precursor to the spin-off or sale of Pfizer generics business, which accounts for 17% of its revenue.

However, Pfizer stated that it intends to wait for three full fiscal years of financial statements from the three segments before it makes any decisions to spin-off or sell its businesses, meaning that Pfizer would only split in 2017 at the earliest.

Hungry for growth

Pfizer also recently reported its second quarterearningsof $0.56 per share, topping the Thomson Reuters consensus estimate by a penny but dropping 10% from the prior year quarter. Revenue also slid 7% to $12.97 billion, missing the $13.01 billion that analysts had expected.

Much of Pfizer’s top line decline was attributed to its loss of exclusivity for Lipitor, its best-selling high cholesterol treatment, and volatility in the emerging markets. A decline in government bulk purchases of its Prevnar pneumococcal vaccine for young children also dented its top line growth. However, some of those losses were offset by a 28% increase in sales from cancer treatments, especially from newer treatments such as Inlyta and Xalkori.

A big part of Pfizer’s second-quarter net income, however, was attributed to the publicspin-offof its animal health unit,Zoetis, in May. Prior to the Zoetis spin-off, Pfizer also sold Capsugel, its drug capsule business, toKohlberg Kravis Robertsfor $2.4 billion in 2011, and its infant nutrition business for $12 billion toNestlein 2012.

Following in Abbott’s footsteps

Abbott Laboratories faced the same predicament as Pfizer for many years. The company was too diversified for its own good, and needed to even out its bets in terms of risk and reward.

Therefore, in January, Abbott spun off its blockbuster arthritis treatment, Humira, and its other experimental pipeline drugs into a separate company,AbbVie. Meanwhile, Abbott Laboratories retained the medical device, diagnostics, nutritional, and generics businesses.

Some conservative investors took the split as a chance to sell the more risk-prone AbbVie to buy more shares of Abbott, since the upcoming patent expirations of Humira and Androgel could cause AbbVie an annual loss of $2.5 billion.

However, more speculative investors scooped up shares of AbbVie, which hasfour potential blockbustersin its pipeline: an orally administered HCV treatment, a gel for Parkinson’s disease, a multiple sclerosis treatment, and a drug for endometriosis. AbbVie CFO William Chase believes that those treatments, if approved, could generate $4 billion to $6 billion in peak annual sales.

Balancing risk with reward

Therefore, Pfizer could have a lot to gain if it split its generics business from its other two units. Like Abbott, the company would be balancing its risk into Germano and Schulman’s divisions, while allowing its generics business to grow at a more conservative rate.

Over the past decade,Actavis andTeva Pharmaceutical Industries have become major threats to leading pharmaceutical companies like Pfizer andMerck. Actavis and Teva have both used lower-margin, higher-volume business models to generate higher top line growth over the past five years, as seen in the following charts.

Both Actavis and Teva have benefited from generic versions of Pfizer’s treatments. Both companiesreleasedgeneric versions of Viagra, Pfizer’s best-selling erectile dysfunction medication, across nine key markets in Europe when Pfizer’s patent ran out earlier this year. Teva also released the generic version, known as sildenafil, in Canada.

Yet, Actavis and Teva are only the tip of the iceberg for Pfizer -- at least 20 other manufacturers plan to release generic Viagra in the near future. Last year, Viagra generated $2.05 billion in revenue worldwide, with over half of those sales coming from the United States, where the drug is under patent until 2020. Faced with these major overseas threats, Pfizer was forced to sell a lower priced version of its little blue pill to remain competitive.

Pfizer’s own generics business has partnerships withMylan Pharmaceuticalsin Japan, ZhejiangHisun Pharmaceuticalin China, and Brazil’sLaboratorio Teuto Brasileiro. Although these partnerships have increased Pfizer’s exposure to the emerging markets, it is also a double-edged sword due to the recent strength of the U.S. dollar.

Warning signs from Merck

Merck is also stuck in the same boat as Pfizer. Last quarter, Merck’s pharmaceutical revenue, which accounts for 84% of the company’s top line, fell 12% from the prior year quarter. Singulair, the company’s asthma medication, suffered an 80% plunge in sales due to its U.S. patent expiration in August.

However, sales of its diabetes drugs, which include Januvia and Janumet, rose 5%, allaying some fears that FDAconcernsregarding Januvia’s link to pancreatic cancer would hurt demand. The rest of Merck’s earnings were a mixed bag, with Simponi, Isentress, and Gardasil performing well, but Cozzar/Hyzaar, Clarinex, and Maxalt all reporting lower revenue.

In the end, however, Merck’s earnings and revenue dropped 20% and 10.6%, respectively, from the prior year quarter. Unlike Pfizer, Merck is still holding on to its animal health unit, which reported a 2% year-on-year decline in sales.

The Foolish bottom line

Even though Pfizer doesn’t intend to sell or spin-off its three business until 2017, it might not stop a major company, such asValeant Pharmaceuticals, from making an offer. Valeant acquiredBausch & Lombin May, after making an unsuccessful bid to acquire Actavis for its generics portfolio. Valeant’s acquisition spree, which has been ongoing since 2010, puts it at the top of the list for potential suitors of Pfizer’s generics business.

For now, investors shouldn’t expect a lot of immediate growth from Pfizer, which is already up more than 20% over the past twelve months. Instead, they should focus on its 3.3% quarterly dividend and fairly stable, low-beta stock price. However, it would be wise to keep an eye on any new developments with its newly separated business segments, which could alter the company’s future substantially.

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